UNEDITED WORKING DRAFT
9 March 2011
Nordic small countries in the global high-tech value chains:
the case of telecommunications systems production
Marek Tiits, Institute of Baltic Studies
Tarmo Kalvet, Tallinn University of Technology
Contents
1. Introduction .................................................................................................................................. 2
2. Literature........................................................................................................................................ 3
3. The state of the art in the global telecommunications equipment production ... 4
4. The importance of the telecommunications equipment industry for the Nordic
countries.............................................................................................................................................. 9
5. Case studies ................................................................................................................................ 13
5.1. Established major brand names: the cases of Nokia and Ericsson............... 13
5.2. Integrated manufacturing service provider: the case of Elcoteq .................. 13
5.3. Disruptive telecommunications service: the case of Skype ............................ 17
6. Discussion and conclusions .................................................................................................. 21
6.1. Industry life cycles and the relocation of the production and innovation. 21
6.2. Open or closed innovation networks, which model will prevail? ................. 22
6.3. Catching-up strategies for the latecomers ............................................................. 23
7. References ................................................................................................................................... 24

Corresponding author:
Marek Tiits, Institute of Baltic Studies, Lai 30, Tartu, Estonia, marek@ibs.ee
1. Introduction
The liberalisation of markets and the globalisation the world has witnessed in
the course of the recent decades has made the movement of capital and goods in
and between the different continents easier than ever before. The greater size of
the market allows for the deepening specialisation. Thereby, the globalisation
allows also for the increasing fragmentation and delocalisation of the various
economic activities that are part of a value chain of any specific product or
service.
Indeed, the total world trade of merchandise and commercial services has
increased from 4,230 billion USD in 1990 to 19,900 billion USD in 2008 (in
current prices)(WTO 2009). At this, the volume of the trade of manufactured
intermediate goods increased between 1988 and 2006 from 2,018 billion USD to
9,580 billion USD (in constant prices). Furthermore, It appears that the
electronics industry has benefited from the on-going trend of globalisation by far
the most, as the share of electronics has increased from 8.1% to 17.4% of the
total trade of manufactured intermediate goods (Cattaneo et al 2010:248).
For long time, the globalisation entailed primarily for off-shoring the production
or customer care activities to lower costs locations. It has, however, become
increasingly apparent since the turn of the century that it is not only the more
cost sensitive production tasks but also the R&D and design of the new products
and services that get increasingly relocated from developed to developing
countries. One can therefore argue that we are witnessing the transformation of
the global production networks into the global innovation networks, where not
only the production but also innovation takes place on the global scale
(INGINEUS).
The aim of the current research paper is twofold. First of all, we seek to
understand at the firm level the strategic considerations that influence both the
location decisions for the production and R&D, and the related global cooperation with other firms and public actors. Secondly, we seek to gather new
knowledge on the possible capability building and catching-up strategies for the
latecomers to the global innovation networks.
We focus on the electronics industry which is characterised both by the very
high R&D investments and the very rapid growth of the global trade. More
specifically, we analyse the grossly different development paths of the four major
telecommunications systems producers in the Nordic countries: Nokia, Ericsson,
Elcoteq and Skype. Nokia was born in 1865, and Ericsson was established in
1876. Both have been well known brand names for decades. Contrastingly,
Elcoteq grew from a small company to the global multinational corporation in
less than a decade only in the 1990s. Skype has become a global communications
solution even faster, and serves today more international calls than any other
telecommunications operator on the planet.
2
2. Literature
Originally, the main focus of the innovation literature was the evolution of
production and innovation systems, as it takes place within the borders of
specific national or regional economies (List 1841; Freeman 1987, Lundvall
1985 & 1992; Porter 1990, Fagerberg et al 2005) Although the global sourcing
and manufacturing arrangements have been around for some three decades, this
attracted among the innovation scholars for long time only modest interest.1
One of the reasons for this is likely to be that the main focus of the innovation
research has been the R&D activities that are characteristic to the developed
nations while the off-shoring of the production processes to the low cost
locations has not included much R&D activities. Furthermore, it has been a
common wisdom among the policy makers that the off-shoring of the relatively
simpler manufacturing or service activities does not pose to the living standards
of the developed countries any significant risks as long as the ‘core activities’
such as the R&D, product design and marketing are retained at home. Therefore
also the policy interest to the globalisation of R&D and innovation has been
relatively limited.
The today’s reality is however that the multinational corporations scout
increasingly the globe for suitable mixes of new markets and lower cost
production possibilities as well as the local competences for the further
development of the product portfolio itself. Such location search is not any more
limited to the developed nations, but includes also the various developing
countries on all continents. The above is together with the increasing uptake-up
of the innovation systems theory and practice in the developing countries
perhaps one of the main reasons why the innovation studies community has
started to pay since the early-2000s increasing attention to the globalisation
(see, e.g., GLOBELICS).
The popular Open Innovation theory is an example of one of the new approaches
that takes a rather idealistic view on the globalisation. Chesbrough draws his
ideas from the success of the open source software (e.g., Linux) but also
multinational firms like IBM or 3M. He argues that the borders between the
enterprise and its environment are blurring, and therefore “the firms can and
should use external ideas as well as internal ideas, and internal and external
paths to market, as the firms look to advance their technology” (Chesbrough
2003, Chesbrough et al 2006). Essentially, the open innovation literature points
out the increasing knowledge intensity of the modern high-tech industries and
the increasingly broad distribution of the various pieces of the useful knowledge.
In an ideal world, therefore, all universities and firms could eventually cooperate in a global open innovation network and share benefits that emerge
from such an arrangement.
Dieter Ernst (2002) is one of the few, who has been advancing this research agenda for a long
time.
1
3
Contrastingly, other strands of the economics literature continue to show that
there continue to be good reasons for the firms to not open up the access to their
R&D results or intellectual capital (Porter 1980), and the globalisation continues
to evolve predominantly in the form of the regionalisation (OECD 2007).
Moreover, it appears from the empirical literature that both the technological
and managerial capabilities for participation in truly global innovation networks
vary significantly both within and between the different major economic powers
such as, e.g., the United States, China, Japan or the European Union (see, e.g.,
Annerberg et al 2010, Tiits & Kalvet 2010).
The transformation of the existing R&D and business networks into truly global
open innovation networks is thereby anything but automatic. In fact, one could
still find both from the economics and business management literature good
arguments for maintaining closely knit multinational corporate structures or
business alliances which continue to control the global value chains and offer
only to a limited number of selected partners access to the core technological
assets or marketing and sales channels.
Thereby, a number of questions remain open both on the theoretical and more
practical policy-making or business strategy level in relation to the globalisation
of the innovation networks. Including the most fundamental one, which is the
more feasible model for a particular enterprise or economy – closed or open
innovation? When are or should be the firms actually employing one approach or
the other? How can the latecomer economies integrate the best into the global
economy so that the benefits to the particular economy would be the greatest?
In order to shed some light on these questions, we undertake in the following an
analysis of the four European firms in one of the most R&D intensive and
globalised industries – the production of the telecommunication systems. In the
following, we introduce these case studies with a brief review of the general
dynamics in this industry and of the role this industry for the three Nordic
economies: Sweden, Finland and Estonia.
3. The state of the art in the global telecommunications
equipment production
The modern ICT visions seek to develop enjoyable information services available
to anyone, anywhere and any time. The fulfilment of the above aspirations
assumes for the continued explosive growth of the computing power and the
bandwidth of the fixed and mobile communications channels and increasing user
friendliness of the information systems that run on top of the more and more
powerful infrastructures (Ducatel et al 2001).
In this broad context, the following two major technological disruptions continue
to take place in the telecommunications industry simultaneously and in a
mutually reinforcing manner:
4
-
the continued technological development and the increase of the
communication bandwidths allows for a shift from the fixed to mobile
broadband communications, and from the PC to all kinds of mobile devices;
the shift from the time-division multiplexing digital networks to the Internet
Protocol (IP) based networks allows for the convergence of a variety of
multimedia communications, including voice, video, file exchange, etc.
In the 1990-2000s, with the advent of the GSM standard and the broad take-up of
the mobile telephony services by consumers, the Nordic telecommunications
equipment manufacturers became the global market leaders both in the
manufacturing of the mobile telephones and the related network equipment.2
The United States and Japan were developing competing standards which have
had internationally less success. This is also why the non-European
manufacturers, such as for example Motorola or Sony, were less successful in the
early phases of the evolution of the mobile telephony industry. As the result,
Nokia had 31%, Motorola 15% and Ericsson 10% of the mobile phone handsets
market in 2000. Ericsson (30%) and Nokia (10%) faced tougher competition at
the mobile telecommunications infrastructure market, where Motorola (USA)
had 13%, Lucent (USA) 11% and Nortel (Canada) 9% of the market in 1999.
(Rouvinen and Ylä-Anttila 2003, Porter & Sölvell 2006: 13).
Nasdaq crash and the emergence of the next generation (3G) mobile telephony
standards3 led to a significant consolidation of the industry in the early 2000s.
For example, Ericsson who was the market leader in network infrastructures,
but had in handsets a weaker market position merged its handsets business with
Sony’s. Siemens merged, for similar reasons, its network infrastructures business
with Nokia, and sold its handsets business all together to the Taiwanese BenQ.
Although the market share of the Asian producers was negligible in the turn of
the century. Various emerging markets actors, such as Samsung, LG (both
Korea), Huawei (China), and others have been, however, building up their
capabilities rapidly. What is more, various integrated microchips and readymade integrated platforms that are instrumental for developing mobile
telephones have became readily available from the various semiconductor
manufacturers, e.g., Qualcomm, Infineon, ST-Ericsson, MediaTek, etc. Thereby,
the mobile telephone market has become from the technological point of view
much easier to enter for the new actors. What matters in the low end of this
market the most is the market power and access to the end customers at large
emerging markets such as, e.g., South-East Asia, Africa, etc.
In order to properly understand the sources of the Nordic competitive strengths in the mobile
communications industry, one should consider the respective investments and the evolution of
the mobile telecommunications in the Nordic countries at least since 1970-1980s.
3 At the time of the development of the original GSM standards, no one could properly estimate
the future importance of the mobile data communications. Therefore, the original GSM standard
foresaw only the possibilities for a very limited (9600 bps) speed of data communications. The
shift from the GSM (2G) mobile telephony systems to the 2.5G (EDGE), 3G and the forthcoming
4G networks is, therefore, foremost about the increasing of the bandwidth that could be made
available for the mobile data communications.
2
5
In the 1990s, the product development and manufacturing were, although
dependent on the independent suppliers of microelectronics components, fairly
closely knit in the Western Europe and in the United States. However, with the
saturation of the European and other developed country markets, the Asia
became both the greatest growing market and the largest manufacturing base.
The whole product development and the whole mobile telephony production
value chain have become truly globalised in the course of the last decade.
For example, the Apple’s iPhone, which is one of the today’s most eye catching
electronics products, is actually manufactured by the Taiwanese Hon Hai
Precision Industry Co Ltd, while the various microelectronics components are
sourced from different companies and manufacturing plants across the globe.
Thus, the various parts of the mobile telephony value chain (Figure 1) are indeed
dispersed across the globe.
Figure 1. Mobile telephony value chain
Source: Sölvell & Porter 2006.
The iPhone 4 display, application processor and memory come from LG and
Samsung in Korea, radio chips come from Broadcom and Intel in the U.S., and
Infeon in Germany; and the various smaller components come from elsewhere
(iSuppli 2010).
The Apple’s iOS platform is in terms of the design of the user interface design in
many ways superior to the competing offers, but there is much more to the
Apple’s success. Apple is unique in its ability to control the whole global value
chain from the product design to sales to end users that takes place in
partnership with local telecommunications operators in a way no other
6
competitor has managed to do. This together with the specialisation in the upper
end of the market allows Apple to reap unrivalled economic benefits.4
Although Apple sells only 4% of all mobile telephones, it collects a remarkable
50% of the total profits of in the mobile handset industry. Contrastingly, the
market leader Nokia has underperformed recently rather badly. Nokia sells 32%
of all handsets, but it has been increasingly competing in the overcrowded lower
end of the market, and this has allowed it to benefit from only 15% of the
industry profits (Figure 2 & Figure 3).
Figure 2. Market shares of the major mobile telephone producers.
Source: Asymco 2010.
The fact that the various components of the mobile telephones are increasingly
readily available to anyone and the whole production chain has become truly
global has shifted the very nature of the market competition in this industry. The
high end mobile telephones have become increasingly powerful networked
computers, and the market competition is not any more about the mastering of
the development and production of the individual telephones, but about the
development and commanding the whole ecosystems of telephones and the
various third party applications which are run on these.
We argue that the Nokia’s and Sony Ericsson’s recent failure in capitalising on
the smartphone market is largely due to the failure5 of the Symbian operating
system (OS) Nokia and Sony-Ericsson have been advancing jointly with some
other manufacturers. Unfortunately, the Symbian consortium has been never
able to establish a consistent OS that would allow for development applications
The various iPhone components cost only $187.5 and the assembly only $6.5 of the $600
iPhone 4 sales price (iSuppli 2010).
5 Sony Ericsson introduced its first Android powered smartphone in the spring of 2010. On
11 February 2011, Nokia announced a new software partnership with Microsoft, another ailing
giant that has failed to establish its software stronghold in the mobile telephone industry
(Bloomberg 2011).
4
7
that run without modifications on a myriad of different handsets produced by
Nokia, Sony Ericsson and others. The development and maintenance of
applications that run on multiple similar but mutually incompatible platforms is
costly. It is also confusing for the end users to figure out what specific version of
the software they should acquire. As the result, the Symbian mobile applications
market never took off, and Apple has overtaken the market leadership with its
innovative touch-screen user interfaces and iTunes App Store, which everyone
else attempts at copying now.
Figure 3. Earnings of the major mobile telephone producers.
Source: Asymco 2010.
The competition for the establishment of a de facto standard of the mobile
operating system is, however, still on-going. Google, another newcomer at the
mobile telephony market, is currently the Apple’s fastest growing and strongest
contender in the fierce competition for establishment of a dominant software
platform6 (Table 1).
Both Apple and Google have also taken serious steps at extending their iOS and Android
platforms beyond mobile telephones to other devices such as, e.g., the tablet computers and flat
screen TVs, and have come up with the Apple TV and Google TV systems respectively.
6
8
Table 1. Worldwide smartphone sales to end users by Operating System.
Q2 2010
Q2 2009
Units
Market
Units
Market
Company
(thousan
Share
(thousan
Share
ds)
(%)
ds)
(%)
Symbian
25,386.8
41.2 20,880.8
51.0
Research In Motion
11,228.8
18.2
7,782.2
19.0
Android
10,606.1
17.2
755.9
1.8
iOS
8,743.0
14.2
5,325.0
13.0
Microsoft Windows Mobile
3,096.4
5.0
3,829.7
9.3
Linux
1,503.1
2.4
1,901.1
4.6
Other OSs
1,084.8
1.8
497.1
1.2
Total
61,649.1
100.0 40,971.8
100.0
Source: Gartner 2010.
The wireless communications networks market is, however, another completely
different market segment of the telecommunications equipment manufacturing
industry. This market contracted in 2009-2010, as the as operators cut spending
during the recession and aggressive Chinese vendors drove down prices. In this
segment, Ericsson continues to be a market leader of (33.6% of the market in Q3
2010), while the Chinese Huawei (20.6%) has performed recently slightly better
than Nokia Siemens Networks (19.8%). The fourth largest player, the U.S. based
Alcatel-Lucent had 16.2% of the market7.
Overall, the developed countries continue to be the main market both for the
high-end smartphones and for the 4G (Long-Term Evolution, LTE) infrastructure
equipment, while the continued rolling-out of the simpler telephones, and the 2G
and 3G network infrastructure will drive the growth at the developing markets.
At this, some of the large developing nations, e.g. China, are also moving very fast
to the 4G technologies. Furthermore, they continue to compete with the major
developed nations for the standardisation of their particular specifications of the
4G networks and protocols. The mobile telecommunications market continues
thereby to be anything but a fully harmonised global market that relies on
universally adopted global standards.
4. The importance of the telecommunications equipment
industry for the Nordic countries
ICT sector is one of the most knowledge and R&D intensive industries both
globally and in the Baltic Sea Region. However, both the size and the knowledge
intensity of the ICT sector vary both across the different ICT sub-sectors
substantially in the different countries in the region. The share of the ICT sector
in the GDP is in Finland and Sweden, among the highest in Europe. This is largely
due to the major contribution of the manufacturing industry, in particular the
manufacturing the telecommunications equipment. The presence of a strong ICT
7
Reuters, 18 Nov 2010, http://www.reuters.com/article/idUSTRE6AI0BN20101119
9
manufacturing sector is indeed what distinguishes the Nordic countries from the
majority of the other European economies, where the ICT sector accounts only
for 3-4% of the GDP (Figure 4).
Finland is particularly strong specialisation in the manufacturing of the
telecommunications equipment. In fact, the Nokia’s remarkable success in the
last decades has made Finland as a small economy in the success of this
company. Nokia contributed more than 2% of the Finnish GDP growth in 2000.
More recently, the consolidation of the industry and the rise of the U.S. and Asia
based competitors changed, however, the situation substantially. The Nokia’s
contribution to the economic growth in Finland was even negative in the course
of the global crisis in 2008-2009 (Ali-Yrkkö 2010: 12). Contrastingly, the
Sweden’s industry is much more diversified which makes it much less dependent
on particular large companies such as Ericsson, or other multinationals that are
headquartered in Sweden.
Figure 4. The ratio of the ICT sector value added to the GDP, 2005
Source: Turlea et al 2009: 46.
The important role of the telecommunications equipment manufacturing in
Finland and Sweden is even more visible in the export figures. The Finland’s and
Sweden’s exports of goods doubled between the 1995 and 2009. The Estonia’s
exports have grown in this period even more rapidly. While this is the case, a
very clear peak can be observed in the exports of the telecommunications
equipment in all three countries around the turn of the century (Figure 5).
10
Figure 5. The share of the telecommunications equipment in the total
exports of goods
0.35
Percent of the total exports
0.3
0.25
0.2
0.15
0.1
0.05
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Estonia
Finland
Sweden
Denmark
EU27
Source: Authors’ calculations, ComExt 2011.
This has, once again, to do with Nokia in case of Finland, Ericsson in Sweden. The
Estonia’s exports in the telecommunications equipment have also predominantly
to do with the above two companies. Their manufacturing service provider
Elcoteq has been for more than a decade responsible for the vast majority of the
imports and exports of the telecommunications equipment to and from Estonia.
The on-going globalisation and in particular the rise of the Asian emerging
economies have brought about the relocation of the manufacturing activities to
the major mass consumption markets in Asia, while the exports from the United
States and Europe have declined. As the result, China became between 1997 and
2007 by far the largest exporter of the telecommunications equipment, while the
market share of the Nordic countries has diminished significantly (Figure 6).
11
Figure 6. The communications equipment export by nation, 1997-2007
Source: ICCP 2010.
One could argue that the rise of the Asian producers has to do with the relatively
lower cost base of these economies and the fact that the Asian markets are
among the fastest growing consumer markets for the (mobile)
telecommunications equipment. However, it is not, as shown above, only the
manufacturing but also the R&D and product development activities where the
Asia is gaining the grounds as compared to the United States and Europe.
We are witnessing a transition of the global production networks that were
about off-shoring certain production activities to the global innovation networks,
where the actual R&D, product development and manufacturing activities are
carried our on the different continents.
In order to shed a light on the location decisions both for the R&D and
manufacturing activities of the major players in the telecommunications
equipment manufacturing, we present first the case studies of Ericsson and
Elcoteq. Thereafter, we analyse the strategy and development of Skype, a
disruptive global telecommunications systems provider that has become in less
than a half decade the largest provider of international calls and challenges the
whole business model of the established telecommunications industry.
12
5. Case studies
5.1. Established major brand names: the cases of Nokia and Ericsson
Ericsson was founded more than a century ago in 1876 as a telegraph repair
shop. What followed was a remarkable success story.
Ericsson telephone exchange supported the first international telephone call in
1950. It was one of the pioneers of the Nordic Mobile Telephone (NMT) and GSM
telephone systems. Today Ericsson continues to be the market leader for the
mobile telephone network equipment manufacturing. It continues to
manufacture in its subsidiary Sony Ericsson the mobile telephones, and offers
from and ST Ericsson also the mobile telephone components and kits to the third
parties.
This chapter is to be finalised.
5.2. Integrated manufacturing service provider: the case of Elcoteq
Elcoteq8 was founded as Lohja Microelectronics in 1984 to support the Lohja
Corporation’s (Finland) development and production of electroluminescent
displays. This business did not advance, however, fast enough and some free
capacity became available in Lohja Microelectronics. Meanwhile, Nokia Mobira in
Finland and Ericsson in Sweden had both developed their first NMT mobile
telephones, for which the full-scale production was held back by the small
components assembly capacity, and they were looking for additional
manufacturing expertise. This is how Lohja Microelectronics became an
electronics manufacturing service (EMS) provider with Nokia and Ericsson as its
largest customers in the early 1990s (Elcoteq 2010).
In 1990, in a way of the preparation for merger with another Finnish industrial
conglomerate Wärtsilä, Lohja Corporation restructured itself and registered its
different business operations as separate companies. The microelectronics was
renamed to Elcoteq. Metra corporation, that had emerged as the result of the
merger, did not consider, however, microelectronics to be its core business, and
Elcoteq went for the management buy-out in 1991.
In the early 1990s, when Swedish and Finnish entrepreneurs were the first to
invest into Estonia, the Elcoteq started with the pilot production in Estonia
already in 1992, and established formally a subsidiary in Estonia in 1993. This
was the very first subsidiary Elcoteq established outside homeland. Although
initially various Asian countries had been considered as a potential location,
eventually a better alternative was found closer to home in Tallinn.
Hereinafter ‘Elcoteq’ refers to the Elcoteq corporation globally, and ‘Elcoteq Tallinn’ refers to
the particular subsidiary which has been established in Estonia.
8
13
One of the Elcoteq Tallinn veterans described the creative destruction that took
place in the early 1990s with the following words: “It was a productive time, the
industry had collapsed and the town was full of unemployed engineers.” The newly
employed engineers were initially sent for training to Finland or Sweden. Later
on, training was increasingly organised locally in Estonia.9
In 1996, Elcoteq Tallinn started to operate as the GSM repair center. Already in
the following year, volume production of the GSM mobile telephones was
initiated, and Elcoteq became the very fist EMS business that started to ‘box
build’ mobile phones for a major brand name from the start to finish. The fact
that Ericsson had subcontracted the whole production of its Ericsson 628 mobile
telephones brought Elcoteq to a completely new level of collaboration with its
clients. Most notably, soon also Nokia followed the suit. What followed can be
characterised as a true co-evolution of the major brand names and and Elcoteq
as an EMS part of their value chain. For the late 1990s, Elcoteq was producing in
Estonia mobile handsets for two market leaders of the time.10
This was a big time both for the Nordic mobile telephone producers and the EMS
businesses, which were working with them, as the European mobile telephony
market was booming and the production and sales volumes went up very
rapidly. This is also very vividly visible both in the Nordic and Estonian foreign
trade statistics. In Estonia, telecommunication equipment reached for the turn of
the century up to 20% of the manufactured exports. In this period, most of the
production technologies and components were imported and virtually all of the
produced goods were exported. The share of local content other than labour
remained virtually nonexistent. Thence, not surprisingly, also the value added
generated in the Estonian electronics industry remained significantly lower than
that in traditional industries, e.g., wood processing, etc. (Tiits et al 2006)
In this period, Elcoteq started also to expand internationally, as it made
increasingly sense to locate the manufacturing activities close to their end
market. To finance the enlargement, the Elcoteq’s shares were listed on the
Helsinki Stock Exchange in 1997. New manufacturing site was established in
Hungary, and an office was established in the United States. The office
established in Hong Kong started to manage manufacturing activities located in
the Southern China, etc. In effect, Elcoteq became within the two short years a
truly global corporation. By the end of the 1999, the Elcoteq’s network of plants
covered already more than ten countries in the three word regions which
experienced the fastest growth: Europe, America and Asia.
When Estonia restored its independence in 1991, its economy was in deep trouble. So was the
whole ex-USSR. Therefore, Estonia started, both for the political and economic reasons,
immediately to reorient its economy to the western markets, which had both a greater
purchasing power and growth prospects. However, as it became evident very soon, the majority
of the electronics industry, which Estonia had inherited, was not competitive at the western
markets and was, therefore, forced to close down (Tiits 2006). As a result of this, experienced
workforce was readily available for the electronics industry in Estonia in the early 1990s.
10 Both the Nokia and Ericsson were the clients of the Finnish EMS firm Elcoteq already since
mid-1980s; and Elcoteq had manufactured the mobile telephone boards for Ericsson already for
a number of years.
9
14
Figure 7. The location of Elcoteq sites
Source: Elcoteq Annual Report 2009.
The business models, which were originally adopted in Finland and Estonia
provided a good starting point, but needed adapting for Hungary, Russia,
Germany, Mexico and China. The Elcoteq’s Finnish and Estonian business
development and engineering staff was therefore actively involved in the
establishment of the new sites elsewhere in the world, and training the local
staff. Also, through these experiences, a well-documented system was
established in Elcoteq for transferring any specific production line from one site
to another. As opposed to some other multinational corporations, the individual
units within Elcoteq continue to rely on uniform standardised technologies and
processes also today.
As discussed above, the NASDAQ crisis brought about consolidation and global
restructuring in the whole ICT and electronics industry from the 2001 onwards.
The large-scale manufacturing of consumer electronics, incl. mobile telephones
and similar, has shifted increasingly to the low cost locations that are nearby to
the final markets. For example, Ericsson moved, as the part of streamlining its
value chains, the manufacturing of its mobile telephones from Elcoteq Tallinn to
the St. Petersburg (Russia).
Also, a number of mergers and acquisitions took place between the ICT
enterprises. The establishment of Sony Ericsson Mobile Communications
company and the subsequent sale of the Ericsson’s own mobile telephone
manufacturing plants to a competitor was, further to the general market
downturn, another major blow for Elcoteq (Elcoteq 2010). Despite the above, in
Tallinn (and in other sites) manufacturing of the Ericsson mobile network gear
and Nokia telephones was maintained for the time being.
Elcoteq had to adjust for a weaker demand and a general slowdown in the ICT
industry. It was acknowledged that the manufacturing activities alone would not
be sufficient for sustaining the profit margins in the changed market
environment. Consequently, Elcoteq started to further its own design, R&D,
engineering and after-sales services. Special New Product Introduction (NPI)
15
centres were established within the Elcoteq to strengthen the co-operation with
clients and their design houses in testing prototypes and preparation for the
actual production.
Initially, Elcoteq engineering centre, which is in charge of the testing the
prototypes and new product introduction, was located in Finland. In 2000, a new
engineering centre was established in Tallinn, Estonia. In 2002 one more
engineering centre was established in Beijing, China. To strengthen its
engineering capabilities even further, Elcoteq bought the R&D unit of the Finnish
mobile telephone and telematics company Benefon in 2002 (Elcoteq 2010).
Although Elcoteq had all capabilities for designing the mobile telephones and
even developed at one point in time one handset for Ericsson, it did not challenge
its main customers in R&D and product development, but remained a contract
manufacturer. The competition continued to intensify in the EMS business on all
fronts in the 2000s. For example, Nokia started to source some of its printed
circuit boards from Foxconn (Hon Hai) and GKI in Asia, and handled the
manufacturing all together in-house in Brazil. In the mid-2000s, Nokia continued
to streamline its supplier network, and gave a preference to larger vertically
integrated suppliers such as the Foxconn and BYD. As the result, eventually,
Elcoteq was forced to downsize significantly also its Nokia handset business
(Seppälä 2010).
Elcoteq started therefore to capitalise increasingly on its telecommunications
equipment manufacturing competences by manufacturing later in the 2000s to
an even broader set of clients. Along with this also a new plants were
inaugurated in Bangalore (India) and St. Petersburg (Russia) in 2005. In the
same year Elcoteq was reincorporated as European Company (SE) and the
regional headquarters were established in Budapest (Hungary) for managing the
European operations. Furthermore, the domicile of the company was transferred
from Lohja to the Luxembourg in 2008.
The recent global financial and economic crisis brought about another
restructuring of the Elcoteq global network. During the 2009, the factories in
Arad (Romania), Richardson (US) and St. Petersburg (Russia) were closed down.
The factory in Shenzhen was consolidated into the factory in Beijing in China.
Part of the Elcoteq Tallinn plant, which served earlier Ericsson, was sold to
Ericsson. With this transaction, some 1200 employees of Elcoteq Tallinn moved
also to Ericsson (Elcoteq Annual Report 2009). After this transaction, Ericsson
continues to produce in Tallinn 4G (LTE) mobile network gear, for which the
Swedish TeliaSonera is among the Ericsson’s first customers.
Today, Elcoteq continues to be in the global comparison a fairly small electronics
manufacturing service provider.11 It continues, nonetheless, to produce both the
mobile handsets and infrastructure systems. Globally, basically all major
telecommunications equipment producers, incl. Nokia, Samsung, LG, Motorola,
Elcoteq revenues were 2090 million USD in 2009. The revenues of the Foxconn and Flextronix
– largest contract manufacturing companies in the world – were respectively 44065 million USD
and 30949 million USD in the same year.
11
16
Sony Ericsson, Huawei, etc., continue to be the clients of Elcoteq. Further to this,
Elcoteq has established itself also in the production of flat screen TVs. (Elcoteq
Annual Report 2009) In Europe, the plant located in Hungary is the main
Elcoteq’s main mass production plant, while Elcoteq Tallinn continues to
produce with its approximately 200 staff for smaller niche markets.
Capacity building and innovation in Elcoteq
First of all, the timing of the internal manufacturing capacity building in Elcoteq
(Lohja Microelectronics) in relation to the emergence of a new industry and the
relative geographical proximity in the Nordic countries were crucial for Elcoteq
to be actually able to attract the market leaders of an emerging new industry as
customers in the early 1990s. The other side of the coin is, however, that Nokia
and Ericsson as large clients managed to lock in Elcoteq into their supply chains
in such a way that it was, despite the upgrading of competences that took place
internally, never able to fully upgrade from the OEM to an ODM business. In fact,
only the world’s largest Taiwan / China-based contract manufacturing service
providers have managed to upgrade themselves into the ODM businesses. In
practical terms, this has often required for spinning the design and product
development activities out from the original EMS business, and establishing a
separate ODM firms that operate fully independently from the original OEM
business (Cattaneo et al 2010: 258).
Elcoteq upgraded their engineering capabilities to an extent that they would be
able to go from OEM to ODM, but unlike some larger Asian (Taiwanese)
competitors, they never did it big time. They cannon compete with their clients
in the same technologies everyone has, so they continue to be dependent on
their clients, such as Ericsson, Huawei or others.
Overall, in Elcoteq Tallinn, internally, a substantial capacity building and
upgrading of the business functions has taken place. However, the Elctoteq’s
business model itself has not allowed for competing with major brand names in
the telecommunications equipment manufacturing. The failure to establish a
strong cluster of local suppliers is perhaps the strategically most important
aspect, where the Estonian economic development strategy has fallen short.
5.3. Disruptive telecommunications service: the case of Skype
Internet was in the 1970-1980s, where the early development of the digital
telephony systems standards started, anything but widespread, and most of the
fixed line data communications run at what is in today’s standards a very low
speed. Voice communications were the primary means of communications, and
the business models and the architecture of the telecommunications systems
were built for billing per minute of use. The explosive growth of Internet in the
1990s brought a major disruption to the whole telecommunications business.
The provision of the Internet services, which was in the early 1990s a minor side
business, became in less than a decade a major business.
17
The spread and increasing speed of the Internet access brought, however, also a
major disruption to the business models and billing. The international telephone
calls have been traditionally for the public telephone operators a premium
market from where significant revenues can be generated. With broadband
Internet access, there is no billing per minute, and international communications
are virtually free of charge. Furthermore, as the potentially available Internet
bandwidth is today in the most occasions already greater than that the
bandwidth of the voice channels in digital (mobile) telephone networks12, it
makes increasingly sense to route the voice calls over the Internet.
This is exactly what Skype and other Voice over IP (VoIP) systems do. Skype is
VoIP software that allows anyone to talk to anyone else in the Internet free of
charge. It allows, for a modest fee, also to route the calls to the ‘old school’
telephone network. VoIP is, thus, a disruptive technology that benefits
enormously from the continued advent of the Internet communications and
carries a potential for altering drastically the business models of the whole
telecommunications industry.
Skype was founded in 2003 the Swedish and Danish entrepreneurs Niklas
Zennström and Janus Friis. Skype’s software development team was from the
very beginning located in Tallinn, Estonia, which became immediately its largest
office in terms of the number of staff. Skype was not the first company to enter
the VoIP market, but its strength in the ease of use, hugely scalable peer-to-peer
architecture and clever marketing made it an immediate success.
The first “beta” version of Skype, which was released in August 2003, allowed for
computer-to-computer voice calls. No other services were available. This very
first software attracted the first 1 million registered users only in a matter of
months. Subsequently additional services (text chat, SkypeOut and SkypeIn calls
to and from the regular telephones, video calls, etc.) and support to additional
devices (Apple Mac, Linux, special Skype Phones and Skype application for
various smartphones) appeared.
Two years later, in Q4 2005, when eBay bought Skype, it had already 75 million
registered users. For today, Skype has more than 560 million registered users,
and, although only a percent of users pay for its services, it has become by far the
largest international voice carrier. What is more, 40 percent of Skype calls are
actually video calls. The ease of use, and possibility of (multiparty) video calls
along with the free service differentiate Skype very strongly both from the other
traditional and VoIP telephone services.13
Skype has gone truly global not only in terms of its customer base, but also in
terms of the location of its business functions during the last five years. As noted
above, it was the combination of the experienced Scandinavian start-up
managers and Estonian engineering talent that were the in the core of the
The bandwidth of the voice channel in the GSM mobile telephone network is 9.6 kbps. Fixed
line digital telephone networks allocate for voice channel 64 kbps. The bandwidth of the usual
end-user Internet access is at the same time between a few hundred kbps and a few mbps.
13 In the first six months of 2010, Skype users made 95 billion minutes of voice and video calls.
12
18
Skype’s immediate success. Soon, as the Skype was seeking to attract
international venture capital and to get closer to major marketing channels, the
corporate headquarters were established in Luxembourg and an office was also
set up in London. Although the headquarters were in Luxembourg, Tallinn and
London remained to be the largest offices, and most of the decision-making
continued to take place between these two offices.
Figure 8. The location of Skype sites
Source: Skype, October 2010.
Once eBay bought Skype in 2005, an office was also set up in the United States,
close to the eBay HQ14. After eBay sold Skype in 2009, the U.S. office continues
essentially as a marketing, sales and support office servicing the Americas15.
Recently, general management of the Skype4Business business line was also
moved to the U.S., as the Americas are globally the largest market for enterprise
communications, and some of the Skype’s strategic partners for this business
line, e.g., Avaya, are also located there.
Skype has also tiny offices the Singapore and Hong Kong in Asia. These offices
are in charge of the marketing, sales and support in Asia. Their perhaps even
more important function is still to keep close contacts with the manufacturers of
the increasing variety different Skype enabled devices (Skype phone, flat screen
TVs, etc.) in Asia.
In Q4 2005, eBay purchased Skype for approximately 2.5 billion U.S. dollars (2.1 billion euros)
of upfront payment, plus potential performance-based consideration (eBay).
http://investor.ebay.com/ReleaseDetail.cfm?ReleaseID=176402&FYear=
15 In November 2009, eBay sold, however, 70% of Skype to a consortium comprising Silver Lake
Partners, CPPIB, Andreessen Horowitz, and the original founders valuing the business at 2.75
billion dollars. In August 2010, Skype filed with the SEC for listing at the NASDAQ stock exchange,
where it seeks to raise up 100 million dollars to in an initial public offering.
http://techcrunch.com/2010/08/09/skype-ipo/ ;
http://www.theregister.co.uk/2009/03/25/skype_biggest/
14
19
Skype has been, typically to a venture capital backed start-up, essentially from its
birth in an aggressive growth phase, ensuring the supply of suitably qualified
labour has been one of the important concerns. Therefore, as it emerged that no
enough suitable labour was available in Estonia, second engineering centre was
established in the Prague in 2007. The Prague centre operates as a satellite of the
primary engineering centre in Tallinn, and the engineers who are based there
report to the team leaders located in Estonia.
In Estonia, also some attempts have been made for initiating co-operation with
higher education institutions for strengthening the supply of the qualified labour.
The co-operation with the education systems of the respective countries has
remained so far, nonetheless, fairly limited, as the public education systems are
always slow to respond and the company in an early expansion phase could not
wait for too long to actually see the results.
Instead, Skype has acquired the required talents rather aggressively, where they
could be found easier and faster, relocating, if necessary, the persons concerned
to one of its offices. The purchase of the Norwegian start-up Sonorit Holding AS,
a provider of voice technology for the Internet, in April 2006 is an example of the
flexibility companies like exhibit in attracting the very top talent. The main
motivation behind this acquisition was really the knowledge and talent this
Norwegian company had on audio-video codecs and on the VoIP systems in more
broadly. As the acquired company itself did not have even office yet in Norway,
an office was set up for them in Stockholm, closest possible location to the
engineering centre in Tallinn. Nowadays, in this Skype Stockholm office some of
the most advanced audio-video R&D takes place in Europe. Given the deep
specialisation and the knowledge pool that is available in this Skype unit, also
close exchange of information takes place there with different research institutes
and universities across the globe.
This is pretty much Skype globalisation story in a nutshell. It is for the most part
about securing the supply of necessary staff or being close to some important
partners/markets. We can add a lot of details on the internals of the VC industry,
and the management / location decisions this has called for, as well as on the
disruptive potential of the technology and business model they have. There is,
however, much less to tell about the capacity building that has taken place in
terms of the engineering and R&D staff.
Capacity building and innovation in Skype
As described above, the majority of the Skype’s engineering activities take place
in Estonia, where these activities were historically rooted. However, as the need
has arisen, globally new subsidiaries have been established either to attract the
required talent (engineering – Stockholm & Prague) or to be close to other
important activities (relations with the international VC and marketing – London
& U.S.; relationships with hardware manufacturers – Asia, etc.).
The cost of an explosive growth, which a successful VC backed start-up must
achieve, is, however, the extremely rapid growing complexity of its corporate
management. This is why Skype has now started to streamline its HR strategy,
20
and to concentrate of specific functions to no more than two locations within the
company. While the very top R&D talents may possibly remain an exception,
where there is a lot of flexibility and interest for co-operation across the globe,
majority of the personnel is now increasingly employed to the existing locations
of the specific teams within Skype that require additional workforce.
6. Discussion and conclusions
6.1. Industry life cycles and the relocation of the production and innovation
As discussed above, the global production networks have been evolving rapidly
at least since the 1980s. For example, IBM was in the beginning of the personal
computers (PC) era a vertically integrated firm. Almost all PC components were
initially designed and produced within one firm, except for the Intel
microprocessor, and the PC operating system that was deliberately sourced from
Microsoft. IBM chose from the very beginning to establish its design as an
industry standard, and hoped to achieve this by allowing the other firms to
produce also the IBM compatible personal computers. Soon, the manufacturing
of the personal computers was farmed out to many firms that produced the
different components, assembled the computers, etc. In the course of the time,
not only the manufacturing and assembly functions but also the development of
the different computer components was increasingly relocated to the East Asia
and to elsewhere in the developing countries. While Intel and Microsoft have
managed to sustain their dominant positions, IBM sold eventually its whole PC
manufacturing business to the Chinese Lenovo in 2004.
The more recent developments in the (mobile) telecommunications equipment
have followed a similar pattern. Nokia and Ericsson, as the Nordic industry
pioneers, designed and manufactured originally all critical components of their
products in-house. Soon, they started contract certain manufacturing functions
out to the firms like Elcoteq or Foxconn while keeping the critical technology
know-how, product design and marketing functions in-house. This did not deny,
however, the competitors from developing similar technologies and products.
Moreover, as the developed markets saturated, the manufacturing as well as the
product design started to be increasingly relocated to the developing markets
which continued to exhibit faster growth. For today, the Nordic manufacturers
find themselves increasingly squeezed between Apple as a new entrant to the
high end of the market, and the various Asian manufacturers, e.g., Samsung, LG,
Huawei, etc., who keep also increasing their market share.
Although it does not get too often referred to in the innovation studies, the
industry life cycles and techno-economic paradigms literature (Vernon 1966,
Perez 2002) explains the above development patterns very nicely. According to
this literature, the various economic activities get gradually relocated from the
developed to the developing economies, as the technologies disseminate, the
initial knowledge advantages vanish and, thereby, the importance of the
economies of scale increases in time. Traditionally, the off-shoring entailed
21
primarily for the relocation of production, after-sales support and customer care,
etc.
What has changed in the recent decades is that the liberalisation of markets, the
development of the ICTs have made working across the borders or even on
different continents easier than it was ever before. This has allowed for an
increasing fragmentation of the production value chains, and has also given raise
to the discussion of the global production networks in the academic literature.
More recently, against the broadly shared assumptions, also the R&D activities
have started to delocalise and relocate. For many, this has given a raise to a
completely new phenomenon: global innovation networks.
Conversely, we argue on the basis of the current case study that the changes
have been actually less than often assumed or feared. First of all, we find it very
important to note that both the main production inputs and the internal
dynamics are very different in the different industries. The ICTs,
biopharmaceutical and automotive industries are responsible for the vast
majority of the global private R&D investments, while the traditional industries
significantly less industrial R&D takes place (Moncada-Paternò -Castello et al
2010).
As discussed above, the foundations of the modern ICT industry, which is more
R&D intensive than any traditional industry, were established in the developed
nations only a few decades ago. Now, that the ICT industry experiences a phase
in the industry life cycle, where the various manufacturing and services activities
get increasingly off-shored to the developing countries, obviously also the
importance of the R&D activities has increased in the off-shoring and foreign
direct investments.16 In our view, much of the earlier global production
networks (global value chains) literature remains, nonetheless, largely valid.
6.2. Open or closed innovation networks, which model will prevail?
Both Nokia and Ericsson are clear focal points of the respective global
production and innovation networks, but these networks are far from being fully
open. It is rather the other way around. Telecommunications industry is highly
likely to continue to experience a major consolidation, as the smaller actors
continue to adopt the more dominant technology platforms and standards.
Thereby, for the major brand names, maintaining the control over the
proprietary technology platforms and thereby the whole global production and
innovation networks continues to be paramount objective in to the corporate
strategy. This is a clear commonality for Nokia, Ericsson and Skype, but also
other major brands like Apple or Google that we have not discussed extensively
in this case study.
Usually, the as the natural resource seeking, market seeking, and efficiency seeking have been
the main motivation for the investment into developing countries. With the relocation of the
science based industries, the strategic technological assets or capabilities seeking behaviour has
also become more important as a motivation for the foreign direct investments. See, e.g., Dunning
& Lundan 2008:67.
16
22
There is a strong argument for the (partial) opening of the production and
innovation networks, when the formation of strategic alliances or similar carries
a promise of extending the already existing market share, or supports the
standardisation of the specific products or services.17 For example, Nokia and
Ericsson involved Elcoteq, and later the other contract manufacturing firms, into
their production network in order rapidly boost the volume of production. Skype
has also started to open up its communications platform for the third party
developers, as the number of different platforms (from PCs to the various mobile
devices to the flat screen TVs, cars, etc.) keeps exploding. Apple and Google
introduced their own smartphone operating systems in order to extend their
existing product range to new hopefully rapidly growing markets. It is, however,
not sufficient to have only an operating system. Therefore, they use their
respective on-line application stores in order to capitalise further on the third
party software and/or content development.
The opening of the production and innovation networks offers, however,
obviously to anyone involved no any guarantees for success. Although Nokia and
Ericsson were originally backing the Symbian smartphone operating system,
they failed to compete with the Apple’s and Google’s in-house developed
operating systems even though it was ultimately made open source. Elcoteq was
eventually cut out of the production of the Nokia and Ericsson mobile phones, as
the market situation changed.
It is, thence, perhaps the most important lesson and reminder from the current
case studies that the ICT industry is internally highly diverse, and the formation
and composition of the specific global production and innovation networks
continues to be highly specific to the individual product or service groups, and
the generalisations at the industry level are necessarily not very useful. The open
innovation model has in certain market situations clear advantages. In the other
situations the ‘closed innovation’ continues to prove more beneficial.
Overall, in our view, the universal open innovation practice remains still a rather
distant dream. It seems perhaps more applicable for the not-for-profit sector
rather than for the firms, where the control of the critical elements of the
intellectual property remains the main source of the market power and revenue
generation.
6.3. Catching-up strategies for the latecomers
The telecommunications industry has faced in the recent decades an increasing
consolidation, as the dominance of a small number of major telecommunications
equipment manufacturers has increased. In fact the consolidation has not taken
place only on the supply side, but also on the demand side, as the large
telecommunications service providers, e.g., Vodafone, France Telecom,
We do not consider here the acquisition of the start-ups that have relevant assets or
capabilities, or the mergers and acquisitions with the competitors as the ‘openning up’ of the
production and innovation networks, but rather a form of the consolidation of the industry.
17
23
Telefonica, etc., have continued to acquire the shares of the various smaller
operators across the globe. As the result, both the clients’ and suppliers’ market
power has increased remarkably, and the barriers to entry have been heightened
for the latecomers to the telecommunications industry. The established major
actors continue to enjoy the vast economies of scale across their whole value
chain from the R&D and production to marketing and sales. For these reasons,
the independent market entry has become increasingly difficult for the
latecomers, unless they are able to challenge the established technological
standards or business models, altering this way ‘the rules of the game’.
China has been successful in utilising the vast market size of its domestic market
in order to reinforce its own technological standards. This has forced the major
equipment manufacturers to customise their already existing products or to
develop new ones. This has, however, allowed also for the domestic latecomer
firms more time for the product development. China has been also successful in
implementing the usual FDI policy recommendations – in increasing the
importance of the local inputs in the actual production, and upgrading gradually
the capabilities of the local suppliers.
The above is obviously not so easy to do in the smaller economies. The case of
the Skype illustrates, nonetheless, that even the tiny newcomer actors can
actually outcompete established major multinational firms, if they are able to
adopt the new disruptive technologies and business models, transforming this
way the rules of the game.
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